How to pay yourself tax efficiently

Each week, we are sharing details on how to make your business more tax-efficient to help with the increasing cost of living and burden of tax. This week, we’re talking about how to pay yourself tax efficiently.

If you operate your business via a limited company, there are three ways you can pay yourself: salary, dividends, and pension contributions. It’s vital you get the structure of your income right, not only from a tax point of view but also considering other factors.

Currently, as a general rule of thumb, being paid by a mixture of salary and dividends can achieve the maximum net income for you personally, depending on how much you need to draw and the profits of the business. However, being paid only via a PAYE Salary can in certain circumstances save more tax overall (because it saves considerable amounts of Corporation Tax at the 25% rate), however, this comes at the expense of net pay – because personal taxes are higher. Meaning, while you save tax overall, the company makes the saving and you personally incur the cost.

As yon can see, this kind of tax planning is incredibly tough to get right. Below, we look at some pros and cons of salary vs. dividends, but this is simply an overview. We recommend you speak to us before proceeding with any planning.

	Pros	Cons
Salary	A salary provides a predictable and regular income stream, aiding in personal budgeting and financial planning. Once paid and recorded on a payroll submission your pay is not restricted by any volatility in profits (unlike dividends) of the business PAYE salaries are tax deductible for limited companies, so you save up 26.5% of Corporation Tax on the salary costs Salary can be changed each month depending on cashflow and doesn’t have to be the same for each director / shareholder giving flexibility that is hard to achieve by just Dividends Business owners have the flexibility to adjust salaries with greater ease compared to dividends	Salaries are subject to income tax and National Insurance contributions, potentially resulting in higher tax bills compared to other methods. Generally, PAYE salaries are the highest personal tax cost of all remuneration routes The company will have to pay employers National Insurance in addition to the gross pay (if the pay is more than £758 per month) which increases the cost to the company by 13.8%
Dividends	Dividends can be tax-efficient, as they are subject to lower tax rates than PAYE income Business owners can choose when to distribute dividends, providing flexibility in managing personal income	Dividends can only be paid if the business is profitable, making this method less reliable during lean periods Dividend payments don’t reduce the company tax liability – they are not tax deductible expenses, unlike PAYE Salaries Limited Social
Pension Contributions	Contributing to a pension can provide tax relief, helping you save on income tax Once money / value is in a pension any growth on the investment is tax free within the pension When you draw from the pension you can extract 25% of the funds tax free Pensions contribute to long-term financial security, especially during retirement	Pension contributions are typically locked in until retirement age, limiting access to funds in the short term When you draw down from the pension this income is subject to Income Tax (effectively taxed like a salary but without any National Insurance to pay) There are annual limits to the amount you can contribute to a pension with tax benefits

Caroline Ward, one of our Principal Advisers, recently worked with a client to establish the best balance of paying themselves tax efficiently. Read the full case study here.

There is always so much to consider with tax planning, especially concerning the balance between dividends and salary. You could structure salaries and dividends to save the most amount of tax overall; however, it doesn’t necessarily give you the best net pay.

To optimise tax efficiency without a practical goal could mean saving tax and leaving money trapped in a limited company. You need to ask yourself the question: Is your tax planning driven by a need to maximise personal income? Or is your tax planning about retaining cash in your business structure for future purposes?

This kind of tax planning requires the assistance of a good accountant and business adviser by your side. Speak to your PA or book a free 1-2-1 session with us by emailing enquiries@a4g-llp.co.uk.